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Optimal tax mix in a two-sector growth model with transitional dynamics

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Author Info
James B. Davies (University of Western Ontario)
Jie Zhang (Victoria University of Wellington)
Jinli Zeng (National University of Singapore)

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Abstract

This paper examines the problem of optimal tax mix analytically in a two-sector growth model with transitional dynamics. Tax revenue is required to provide a pure public good. The key problems are: over-consumption of leisure under labor income or consumption taxes; and under-investments in human and physical capital under income taxes. Without investment subsidies, consumption taxes do better than uniform income taxes, but can be improved on locally via positive taxation of physical capital income and a negative tax on labor income. With subsidies the first best can be achieved in a system where: (i) if consumption and labor income taxes are non-zero they are of the same rate but opposite signs, (ii) the tax rate on physical capital income exceeds that on labor income, (iii) subsidy rates on investments equal income tax rates, for both forms of capital. In any given circumstances, a range of alternative tax mixes may provide equivalent results. This result, combined with practical constraints, may help to explain the variety of tax mixes observed across countries.

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Paper provided by National University of Singapore, Department of Economics in its series Departmental Working Papers with number wp0105.

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Length: 48 pages
Date of creation: Dec 2000
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Handle: RePEc:nus:nusewp:wp0105

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Related research
Keywords: Growth Transitional dynamics Optimal taxation Subsidies

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Find related papers by JEL classification:
E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
O40 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Kirk A. Collins & James Davies, 2003. "Measuring Effective Tax Rates on Human Capital: Methodology and an Application to Canada," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
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